More with Less

The steady beat of bad economic news keeps falling like rain on a tin roof. We don't hear each drop or acknowledge its presence but, we sure can tell it is coming down out there. We know that hundreds of thousands of families are dealing with foreclosures. Realty Trac just informed us that 233,000 households received foreclosure notices in January 2008. The nearly 60% increase in foreclosure was accompanied by a 90% increase in bank's taking the homes onto their books. Home prices fell drastically across the last quarter of 2007 according to the S&P Case Shiller Index. The index booked its largest ever decline with prices falling between 9% and 10%. If prices in these 20 cities are seen as nationally representative, we can roughly estimate a loss of paper wealth in US housing at $1.9trillion across the last three months of 2007. No wonder it feels like a long drenching storm.

We have gotten enough information to understand how this bust is proceeding and which shoe is likely to fall next. Housing buoyed the economy in several essential ways. The decline of housing is exerting a drag in exactly the same ways that is once helped. Vast new borrowing opportunities mixed with the belief among lenders and borrowers that home price always and only rise created the boom. This led to a borrowing bonanza that drove up real estate prices. Belief in the house prices always rise prophecy was self fulfilling. Rising real estate prices created profit opportunities for firms, lenders and home owners. In the mean time millions felt wealthy, wise and safe. Others got employed building, appraising, financing, bundling mortgages, insuring, decorating, renovating and selling stuff for the great American house. Many cashed in by cashing out. They refinanced and extracted wealth. The cash out refinancing boom was something to behold. In several of the early years of the twenty-first century more dollars were gotten through home refinancing than all increases in disposable income. Thus, we came to rely on clear skies on the home front to feel wealthy, extract cash, sell for gains and invest for the future. All that is running in reverse now. Belief and house prices have been called into question.

Let's look at what running in reverse looks like. It rains a lot. Paper gains become paper losses. You can't refinance your house. Your house is worth less than you already owe on the property. You can't easily refinance and you can't cash out the increasing value of your house because your house is not increasing in value. Millions already owe more than their homes are worth, millions more will join the ranks of the underwater mortgage borrower by the end of the year. Jan Hatzius, Chief economist for Goldman Sachs, estimates 15 million US households will owe more than their homes are worth by the end of 2008. His is a generous estimate. At the present rate of house price decline that number would be several million higher. Mark Zandi for Moody's Economy.Com estimates that 10% of Americans, 8.8million households, already owe more than their homes are worth. Another way to say this is that we are at or below the statistical point where the average American owns more than half the value of his/her home. In September of 2007 the average America household owned 50.4% of their home, by now that number has almost certainly fallen below 50%. Thus, the average American owes less than half their home. House prices are falling fast. At this rate millions are forced to try to arrange short sales- gaining lender permission to sell a house at below the total mortgage value. All the foreclosures, the mortgage losses, the underwater homes add to inventory and depress prices. Falling prices create falling prices. Mark Zandi's estimate is that for every foreclosure in a neighborhood, there is a 1.5% decrease in the value of the other homes on the block. In January 2008 the inventory of unsold homes on the market rose 5.5% to 4.2million homes or a 10.3 month supply. The government sponsored mortgage buyers Freddie Mac and Fannie Mae announced losses of $6billion across the fourth quarter of 2007. This calls into question how much assistance they will be able to offer, despite recent changes in regulations governing the size of mortgages they can buy and the size of their mortgage portfolios.

The same market forces that inflated the bubble are deflating it now. What about the political, cultural and contextual forces? An income starved middle class, a deep belief in asset inflation and get rich quick schemes fused with easy credit and lax regulation. If we want to prevent this from repeating again, we need to learn both the specific economic lessons and the broad historical lessons of this boom and bust. We badly need long term sustained wage growth. We need to move away from speculation and debt as middle class income schemes.